The M & A Facebook Game

I was desperate. I wanted so much to be out of the business that had taken a nosedive since some unanticipated, well-financed competition appeared on the scene. Ten months earlier, my partner Dan and I had parted company, recognizing that our start-up enterprise wasn’t growing fast enough to support both of us and, with just a minority interest, I had agreed to leave. But I couldn’t get out of my shared responsibility for the bank loan which provided critical working capital.

Buried in my own separate start-up effort with Financial Managers, I was relying on Dan’s survival instincts to keep our company afloat. We had hoped to reach a critical mass of revenue and profitability within five years and sell to one of our better-established competitors. Unfortunately, the recession of the early ’80s hit us with its tidal wave of 18-21% interest rates, and the ship began to sink.

Enter John, a local guy who’d been tracking our business for a number of months and was aware that Dan was bucking a very strong tide. John talked a great game, seemed to understand a lot of the complexities of the business, knew the industry, and said that he represented substantial capital sources.

I wanted so much to believe him that I didn’t check him out. I was preoccupied with my new consulting business, and the joint venture that I shared with Dan was an albatross that kept dragging me back in hopes of salvaging my bank guaranty. But it wasn’t to be. Over a month’s time, during which he promised to part the waters and lead us to the Promised Land, John simply became non-credible. The calls that I ultimately made – and should have made after our first meeting – confirmed that he was a pathological liar and a total con artist. His management experience? Zero. His financial resources? Zero.

By the end of that game, we were at the end of our rope. We liquidated the company, and I spent the next ten years paying back the bank. It was an expensive way to develop the healthy skepticism of an effective financial manager.

Twenty-five years later, it’s 2007 and everyone has the merger bug (see Alligator Bites, below). The word is that investment money abounds. Valuations are 8x and 10x EBITDA. Acquire or be acquired. There’s top-line fever again. Organic growth takes too long.

The phone rings. “I’m calling from ABC Capital. We represent a client with a strong interest in your industry and an appetite for acquisitions. Have you ever considered selling…?”

The phone rings again: “I’m with XYZ Advisors. We help to streamline and package companies for sale. We can determine what your business might be worth and then help you find the right buyer…”

Who are these people? Whom do they represent? Just what are they selling?

Most often, they’re staff people in investment banking houses and M & Ashops making cold calls and just “dialing for dollars.” Their organizations may be perfectly legitimate, but most often they’re calling because they want to make money off you. Cut to the chase with the following questions:

  • “What is the name of your client?” In 95% of legitimate acquisition inquiries, there’s no need to conceal the name of the prospective acquirer. If this isn’t readily divulged, it’s a fishing expedition. Hang up.
  • “What do you know about my company?” Anyone with a serious interest would at least be familiar with the content of your website, would know the name of the principals from public filings, would be able to identify some of your primary customers, and would have a rough idea of your size.
  • “What does your firm do?” AllM & A firms do valuation work – that comes with the territory. If they’re leading with that in their conversation with you, then they’re simply looking for work to keep their junior staffers busy.
  • “What’s your experience in my industry?” A legitimate acquisition inquiry will be accompanied by an understanding of your industry dynamics and demographics. If the caller wants to represent you as a seller, his/her organization should have industry knowledge – you don’t want to pay for their learning curve.
  • “What’s your M & A track record?” Beware the investment banker without a personal history of deals. Reference his/her web site, bio, legal counsel and accountants, and especially former clients.

So, with satisfactory responses here, you reach a comfort level with the acquirer’s intermediary or, in the case of a direct contact, you know the prospective acquirer. What then?

  1. You sign a mutual non-disclosure agreement.
  1. You usually host the first visit, most often without distracting your employees by telling them what’s happening. This involves a tour, a discussion of your products/services, and shared perceptions about the marketplace. You might discuss your balance sheet at this point.
  1. Remember from the outset that you’re in a selling mode, making your best case, but you’re also in a poker game, holding your cards close. It’s O.K. to acknowledge inefficiencies, misdirected efforts, or unusual expenses – “normalizing” for these costs will add to your pro-forma bottom line and increase your value.
  1. Recognize that your gross margin percentage, in both product and service businesses, is likely to be more useful than your bottom line in setting your valuation. Most acquirers feel that they can control selling, general and administrative (SG&A) expenses, but if the basic economic model is broken, the discussion won’t go very far.
  1. Continuing in your best sales mode, describe the opportunities that might be available to you with the synergies and greater resources that the acquirer could provide.
  1. Finally, if all goes well, you might suggest continuing the dialogue in a follow-on meeting on the acquirer’s turf. This ups the ante. You’ll need an investment banker or anM & A lawyer on your side when you move from tactics to strategy.

As I discovered 25 years ago, the chances of all of this happening with an unknown person calling you out of the blue are remote. It’s far better to be intentional in building value in your company, and then proactive in your selling strategy – developed from the start with outside counsel. Negotiating out of desperation doesn’t offer much leverage.

Alligator Bites

“…Private-equity firms are enjoying a success that eclipses that of the Michael Milken era of the 1980s, when leveraged buyouts (LBOs) came into vogue. Through the first three quarters of 2006, private-equity funds yielded an average 12-month return of 23.6 percent, versus 9.7 percent for the S&P 500, according to Thomson Financial. Over the past three years, buyout firms have averaged a 15.6 percent return, compared with 9.9 percent for the index.

“As private-equity funds have consistently beaten the markets, money has poured in by the billions. In 2007, according to industry professionals, U.S. private-equity firms could raise well more than last year’s record $215 billion. Among the biggest firms, Kohlberg Kravis Roberts (KKR) recently closed a $16 billion fund, Goldman Sachs Capital Partners is rumored to be raising a $19 billion fund, and The Blackstone Group is said to be building a stockpile of more than $20 billion. Currently, by some estimates, private-equity firms are collectively sitting on a $400 billion war chest.”

– “The Buyout Binge” by Joseph McCafferty CFO Magazine, April 2007

Grab the buckets! Don’t miss the trickle-down effect!

Draining the Swamp

Largest Local Investment Banks:

2006 Deals Total Value
1. Covington Associates 20 $ 1.6B
2. Capstone Partners LLC19$ 750M
3. Downer & Company 14 $ 713M
4. Revolution Partners 13 $ 200M
5. America’s Growth Capital LLC 11 $ 2.0B
6. Grant Thornton LLP 11 $ 134M
7. Tully & Holland 10 $ 77M
8. Provident Healthcare Partners 9 $ 307M
9. Shields & Company Inc.9$ 287M


Source: 2007 Book of Lists Boston Business Journal